When Is A ‘Buy’ Not A Buy? Every Time

Given the litigious nature of our society, I’m actually surprised it took this long for someone to launch legal action against a Wall Street Internet analyst. After all, it’s been almost a year since Internet stocks began their painful descent, causing thousands of investors to take a red-ink bath.

But should the arbitration case filed by an investor against Merrill Lynch, star analyst Henry Blodget and a Merrill broker prove successful, expect many more to follow.

And if it’s not successful? Expect many more to follow anyway! Hey, I told you this was a litigious society.

One positive outcome either way would be if Wall Street banks changed their deceptive ratings system for stocks. Back to that later, though. First, let’s look at the details of this particular case, as outlined in the Wall Street Journal.

The investor in question bought about 4,600 shares of wireless infrastructure player InfoSpace in March 2000 (there’s trouble already) at $122 to $133 per share, based on the advice of his broker and a “buy” recommendation on the stock by Blodget.

Two months later, INSP shares were selling for around $60. (They closed Thursday at $3.72.) The investor said in a filing with the New York Stock Exchange that he wanted to unload his shares then and cut his losses, but was persuaded by the Merrill Lynch broker, Michael Healy, to hang tough.

Here’s where the waters get murky. According to the arbitration filing, Healy told the investor he had spoken with Blodget, who reiterated his support of INSP and a price target of $100 per share. Merrill maintains Healy did not tell the investor he had talked to Blodget about InfoSpace.

The investor claims – and this is the crux of the case – that Blodget continued to hold to his “buy” recommendation on INSP in order to protect Merrill’s interest as the financial adviser for Go2Net, which was looking to be purchased. InfoSpace bought Go2Net for $4 billion last July, a deal the investor argues would not have happened had INSP shares continued to plummet.

Merrill counters that Blodget knew nothing of the InfoSpace acquisition of GNET until days before the deal was announced last July 26. Further, the WSJ reports, Merrill said in a prepared statement that INSP had been “branded very risky by the Merrill rating system.”

And there’s the real problem. No one merely looking at Blodget’s “buy” recommendation on InfoSpace could possibly conclude that it actually means “very risky,” unless they understand how the ratings systems used by investment banks work. In a nutshell, it goes like this: “strong buy” means buy. Anything else – whether it’s “buy,” “market outperform” or “hey, it’s your money” – means sell.

While trading veterans know this, many of the less-experienced investors who flocked to ‘Net stocks since 1998 have had to learn the hard way. While I doubt the arbitration case against Merrill and its two employees will conclude favorably for the investor – who, after all, ultimately must bear some responsibility – maybe it will force the big investment banks to drop the duplicitious code language and tell it like it is.

But I’m not holding my breath.

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